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Market Comment April 27 2013

April 27 2013 - Illusion and reality, truth and science -- the markets are fascinating because there are so many concepts and ideas many are false and some are very concrete. Technical Analysis, tries very hard to be a science, using charts of price (and volume) to try and predict the future based on the past. Many of the ardent believers come from technical backgrounds, doctors, scientists, programmers and engineers are commonly found in $2,000 a-pop seminars on how to read the Stochastic-RSI or draw an Elliott Wave.  I am as guilty as the rest  -- my black and white view of the rational world is always trying to instill order n the markets. 

From simple charts you progress to building automated trading programs that can back test results. From this you learn a few important lessons; the first is that no squiggly line works perfectly. In fact back testing many basic indicators like MACD and RSI shows them to be little more predictive than a coin toss. Second thing you learn is that charts are backward looking and cannot warn you that tomorrow the World Trade Centre will be attacked, or that the executives are going to be caught  cooking the sales forecasts at Enron and Nortel.  So news and fundamentals will always trump Technical Analysis. Third you must use common sense and even experience. This is why many traders can outperform computer trading. Today I have a great example. I will show you how many of my favourite indicators have or are about to turn bullish and why I choose not to follow them this time. Every bad boy knows rules are meant to be broken!

The long Term Bull and Bear remain positive so we are supposed to be bulls.

(click on any graphic to enlage it.)

The Nasdaq summation index has crossed back over, but remember this can be a very unreliable indicator and it just flopped over (could this be a whipsaw?)

 Also more disturbing, the YP Primary Sell Indicator is now positive when it was negative last week. This is the most damming of the charts I am fighting. But really is it just me or is it looking a little flacide. 

But On the Other Hand 
But now here is why I am trying to ignore my charts, based on experience. First off look at how the markets behaved going in to “Sell In May” the last three years.




If you look closely there was almost always a little surge upward just as the markets turned direction. The reason these surges happen is some human psychology, people hate to miss out on a rally. Everybody else is getting rich and you are left behind. If you are market savvy you spot these trends early, often with an attitude that things stink but “how much worse can it get?” and so the savvy traders buy. As the trend matures more people buy in and of course someone must be asleep and see it later than the rest. Not that these people are stupid, they can see the market is high, but it keeps going up! Headline goad them about new highs, or some little old lady who doubled her life savings buying Goggle stock.  The talking heads on CNBC all look very please with their funds performance and see only blue sky and rainbows. But don't forget all the savvy buyers are already in, by definition all that are left to buy now are the remaining sleepy few. When they are done buying, who will take the equity higher? Well the answer is no one. I think of the market at moments like that are a bit like trying to sell your dying video rental store in this market. All you need to find is the last sucker to not see what has happened long ago.

So just how do you know when to ignore the advice your charts give . . .

We begin our analysis with a few theories;
1)     Sell in May has been working for a few years but is not perfect
2)     The market failed here before, but record highs do get broken
3)      Commodities are in rough shape, China is weak and the world’s non-commodity based economies like Europe are in tatters. However the news in the US is mostly OK.

One place you can find a clue of a end of a cycle, is if the former leaders are rotating to become laggards. The following stocks all have had long term advances, so how are they doing lately?

Mentioned here as a buy repeatedly -- DECK Deckers outdoors, maker of the famous (and over priced) UGG Australia boots.

Celgene also one of my top picks, now pulling back slightly. 

Finally my stable soldier with stable dividends and earnings - the makers of Prozac (the drug not the band) Eli Lilly  

Another motherhood and apple pie stock Procter and Gamble also is retracing;

Of course you followers of the DOW theory watch the big transportation companies like Federal Express and know the economy can not do well if goods are not moving. Transports are early predictors of future weakness or strength. 

It is not just stocks, most commodities are weak, copper continues a downward slide. 

Of course not every chart is off -- or we would not have had a rally this week, but notice how the S & P 500 has formed a double top. A double top predicts a sell of about 60% of the time correctly, not a certainty but a warning sign. Also add to that the "consolidation" we are in, a consolidation means the market is moving sideways, that of course indicates market indecision

A significant number of the NYSE stocks remain below their 50-day moving average and as I mentioned before this is often one of John Murphy's the key predictors of market direction. The MACD line (at the top) remains under zero although in last week's rally it did manage to point upward toward the zero line. Further down we see that currently some 60% of NYSE stocks are above their 50 day moving average. In this case, the odds favour a slip back soon to less stocks staying above the 50 day moving average and as you can see from prior months that leads to a sell off. 

The Name is Bond -- Treasury Bond
Casting our detective work further a field I am bringing up one last resource. US Bonds often move in the opposite direction to stocks. The graph from the bond market is clear, the 20 year treasury bond is heading up and either the climb must reverse or equities must sell off the two can not keep moving up. My money is on the bonds going further up and the market pulling back.

So we have a mixed bag of signals. Some key stocks retracing, some rotation but no clear signals like we had last week. We have some history that shows in the last four years you should sell in May, but the sell in May indicator does not work every year. Clearly the charts are moving sideways so there is indecision everywhere. 

The news media has many possible culprits for and against a sell off, no matter what happens in May they will blame it on one of these things below: 

Sell in May:
Slow Growth 
Commodity Bubble Ends
China slows

We Grind Up From Here:
The Great Rotation into Stocks
67% of firms beat earnings estiamate
The Fed Moves Fast To Print Money

I feel that if this rally continues it will not be vigorous at all, but if it fails it could be like any of the prior 3 May sell offs, nothing big, just a pull back.  In other words the risk of holding equities is higher now than the risk of missing a slow up trend. 

Cash is a position too. As a small investor you can select the luxury of simply being in cash for the next few weeks until things are clear. As for me I am more than 50% in cash, what is left is very stable dividend equities and some "opening positions" in some short ETFs. Primarily I am short the Vix (VXX), Canadian market, gold mining firms (DUST etf) and some US high flyers (hdge etf). This week those have been not doing well, but as I said these are small opening positions, once they start to show strength then I will add to my positions.  If we get to May 15 with no pull back, I will liquidate these positions.